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Portfolio reallocation and exchange rate dynamics

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  • Ding, Liang
  • Ma, Jun

Abstract

This paper explains exchange rate dynamics by linking financial customers’ foreign exchange order flow with their dynamic portfolio reallocation. For any currency pair in a particular period, one currency has higher assets return than the other and can be considered the high-return-currency (HRC). Financial institutions attempt to hold more HRC assets when they become more risk-loving or the relative return of the assets is expected to increase. Such a portfolio reallocation generates buy order toward the HRC and the currency appreciates. As the HRC changes over time, the direction that the relative return and risk appetite affect the exchange rate varies in different regimes.

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Bibliographic Info

Article provided by Elsevier in its journal Journal of Banking & Finance.

Volume (Year): 37 (2013)
Issue (Month): 8 ()
Pages: 3100-3124

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Handle: RePEc:eee:jbfina:v:37:y:2013:i:8:p:3100-3124

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Web page: http://www.elsevier.com/locate/jbf

Related research

Keywords: Exchange rate dynamics; Portfolio rebalance; Carry trade; Risk appetite; High return currency;

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